Banks Owe Billions to Executives - 31-Oct-2008 -

Banks Owe Billions to Executives

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Financial
giants getting injections of federal cash owed their executives more
than $40 billion for past years' pay and pensions as of the end of
2007, a Wall Street Journal analysis shows.

The government is seeking to rein in executive pay at banks getting
federal money, and a leading congressman and a state official have
demanded that some of them make clear how much they intend to pay in
bonuses this year.

But overlooked in these efforts is the total size of debts that
financial firms receiving taxpayer assistance previously incurred to
their executives, which at some firms exceed what they owe in pensions
to their entire work forces.

The sums are mostly for special executive pensions and deferred
compensation, including bonuses, for prior years. Because the
liabilities include stock, they are subject to market fluctuation.
Given the stock-market decline of this year, some may have fallen
substantially.

Some examples: $11.8 billion at Goldman Sachs Group Inc., $8.5 billion at J.P. Morgan Chase & Co., and $10 billion to $12 billion at Morgan Stanley.

Few firms report the size of these debts to their executives.
(Goldman is an exception.) In most cases, the Journal calculated them
by extrapolating from figures that the firms do have to disclose.

Most firms haven't set aside cash or stock for these IOUs. They are
a drag on current earnings and when the executives depart, employers
have to pay them out of corporate coffers.

The practice of incurring corporate IOUs for executives' pensions
and past pay is perfectly legal and is common in big business, not
limited to financial firms. But liabilities grew especially high in the
financial industry, with its tradition of lavish pay.

Deferring compensation appeals both to employers, which save cash in
the near term, and to executives, who delay taxes and see their
deferred-pay accounts grow, sometimes aided by matching contributions.
In some cases, firms give top executives high guaranteed returns on
these accounts.

The liabilities are an essentially hidden obligation. Even when the
debts to their executives total in the billions, most companies lump
them into "other liabilities"; only a few then identify amounts
attributable to deferred pay.

The Journal was able to approximate companies' IOUs, in some cases,
by looking at an amount they report as deferred tax assets for
"deferred compensation" or "employee benefits and compensation." This
figure shows how much a company expects to reap in tax benefits when it
ultimately pays the executives what it owes them.

J.P. Morgan, for instance, reported a $3.4 billion deferred tax
asset for employee benefits in 2007. Assuming a 40% combined federal
and state tax rate -- and backing out obligations for retiree health
and other items -- implies the bank owed about $8.2 billion to its own
executives. A person familiar with the matter confirmed the estimate.

Applying the same technique to Citigroup
Inc. yields roughly a $5 billion IOU, primarily for restricted stock of
executives and eligible employees. Someone familiar with the matter
confirmed the estimate.

The Treasury is infusing $25 billion apiece into J.P. Morgan and
Citigroup as it seeks to get credit flowing. In return, the federal
government is getting preferred stock in the banks and warrants to buy
common shares. The Treasury is injecting $125 billion into nine big
banks and making a like amount available for other banks that apply.

It's imposing some restrictions on how they pay top executives in
the future, such as curtailing new "golden parachutes" and barring a
tax deduction for any one person's pay above $500,000. But the rules
won't affect what the banks already owe their executives or make these
opaque debts more transparent.

Asked about the Journal's calculation, the Treasury said, "Every
bank that accepts money through the Capital Purchase Program must first
agree to the compensation restrictions passed by Congress just last
month -- and every bank that is receiving money has done so."

Bear Stearns
Cos., the first financial firm the U.S. backstopped, owed its
executives $1.7 billion for accrued employee compensation and benefits
at the start of the year, according to regulatory filings. When Bear
Stearns ran into trouble after investing heavily in risky
mortgage-backed securities, the government stepped in, arranging a sale
of the firm and taking responsibility for up to $29 billion of its
losses.

The buyer, J.P. Morgan, says it will honor the debt to Bear Stearns
executives, which it said is shrunken because much of it was in stock
that sank in value.

J.P. Morgan will also honor deferred-pay accounts at another institution it took over, Washington Mutual
Inc. It couldn't be determined how big this IOU is. J.P. Morgan's move
will leave the WaMu executives better off than holders of that ailing
thrift's debt and preferred stock, who are expected to see little
recovery. J.P. Morgan's share of the federal capital injection is $25
billion.

Obligations for executive pay are large for a number of reasons.
Even as companies have complained about the cost of retiree benefits,
they have been awarding larger pay and pensions to executives. At
Goldman, for example, the $11.8 billion obligation primarily for
deferred executive compensation dwarfed the liability for its
broad-based pension plan for all employees. That was just $399 million,
and fully funded with set-aside assets.

The deferred-compensation programs for executives are like 401(k)
plans on steroids. They create hypothetical "accounts" into which
executives can defer salaries, bonuses and restricted stock awards. For
top officers, employers often enhance the deferred pay with matching
contributions, and even assign an interest rate at which the
hypothetical account grows.

Often, it is a generous rate. At Freddie Mac,
executives earned 9.25% on their deferred-pay accounts in 2007,
regulatory filings show -- a better deal than regular employees of the
mortgage buyer could get in a 401(k). Since all this money is
tax-deferred, the Treasury, and by extension the U.S. taxpayer,
subsidizes the accounts.

In addition, because assets are rarely set aside for executive IOUs,
they have a greater impact on firms' earnings than rank-and-file
pension plans, which by law must be funded.

Bank of America
Corp.'s $1.3 billion liability for supplemental executive pensions
reduced earnings by $104 million in 2007, filings show. By contrast,
the bank's regular pension plan is overfunded, and the surplus helped
the plan contribute $32 million to earnings last year.

While disclosing its liability for executive pensions, the bank
doesn't disclose its IOU executives' deferred compensation, and it
couldn't be calculated. The bank's share of the federal capital
injection is $25 billion.

Bank of America has agreed to acquire Merrill Lynch
& Co. Merrill is a rare example of a firm that has set aside assets
for its deferred-pay obligation: $2.2 billion, matching the liability.
Morgan Stanley also says its liability for executives' deferred pay is
largely funded.

To be sure, deferred-compensation accounts can shrink. Those of
lower-level executives usually track a mutual fund, and decline if it
does. Often the accounts include restricted shares, which also may lose
value, especially this year. To the extent financial-firm executives
were being paid in restricted stock, many have lost huge amounts of
wealth in this year's stock-market plunge.

The value of Morgan Stanley Chief Executive John Mack's
deferred-compensation account declined by $1.3 million in fiscal 2007,
to $19.9 million; much of it was in company shares. Mr. Mack didn't
accept a bonus in 2007.

Executives can even lose their deferred pay altogether if their
employer ends up in bankruptcy court. When Lehman Brothers Holdings Inc. filed for bankruptcy last month, most executives became unsecured creditors. The government didn't come to Lehman's aid.

In assessing liabilities, the Journal examined federal year-end 2007
filings by the first nine banks to get capital injections, plus six
other banks and financial firms embroiled in the financial crisis. In
many cases, the firms didn't report enough data to estimate their
obligations to executives. As for identifying amounts due individual
executives, company filings provided a look at only the top few, and
not a full picture of what they were owed.

Just as banks aren't the only financial firms getting federal aid
amid the crisis, they aren't the only ones facing scrutiny of their
compensation programs.

Struggling insurer American International Group
Inc. agreed to suspend payment of deferred pay for some former top
executives pending a review by New York state Attorney General Andrew
Cuomo. Mr. Cuomo is also demanding to know this year's bonus plans for
the first nine banks getting federal cash, as is House Oversight
Committee Chairman Henry Waxman.

Among the payouts AIG agreed not to make are disbursements from a
$600 million bonus pool for executives of a unit that ran up huge
losses with complex financial products. AIG also is suspending $19
million of deferred compensation for Martin Sullivan, whom AIG ousted
as chief executive in June. His successor as CEO, Robert Willumstad,
who left when the U.S. stepped in to rescue AIG in September, has said
he's forgoing $22 million in severance because he wasn't there long
enough to execute his strategy for AIG.

However, the giant insurer -- whose total liability for its
executives' deferred pay couldn't be calculated -- says most of the
managers will receive the compensation. "Of course, we'll be looking at
all these to make sure they're consistent with the requirement of the
program," said spokesman Nicholas Ashooh.

AIG isn't eligible for the government's capital-injection plan,
since it's not a bank, but it's getting plenty of U.S. aid of another
sort. The Treasury has made $123 billion of credit available, a little
more than two-thirds of which AIG has borrowed so far.

Fannie Mae
and Freddie Mac also don't get in on the capital-injection plan for
banks. But under a federal "conservatorship," the Treasury agreed to
provide each with up to $100 billion of capital if needed. In return,
the government got preferred shares in the firms and the right to
acquire nearly 80% of them.

Their regulator, the Federal Housing Finance Agency, says it will
bar golden-parachute severance payouts to the mortgage buyers' ousted
chief executives. The executives remain eligible for their pensions.

Fannie Mae had a liability of roughly $500 million for executive
pensions and deferred compensation at the end of 2007, judging by the
size of its deferred tax assets. A spokesman for the firm wouldn't
discuss the estimate or whether the executives would get the assets.

At Freddie Mac, most will. "Deferred compensation belongs to the officers who earned it," said Shawn Flaherty, a spokeswoman.

Indeed, in September Freddie Mac made its deferred-compensation plan
more flexible, allowing executives to receive their money earlier than
initially spelled out. "Officers were nervous about market changes,"
said Ms. Flaherty. "We wanted a retention tool for top talent."

Source: The Wall Street Journal